- USD risks skewed to the upside. US growth leader among peers.
- April PCE to support a more restrictive Fed.
- RBNZ and MNB poised to hold. BOI cut. SARB hike. BOK hawkish hold.
Positive progress over reopening the Strait of Hormuz can further fuel the rally in risk assets. President Donald Trump on Sunday said “The negotiations are proceeding in an orderly and constructive manner” but stressed there is no rush to strike a deal. Encouragingly, Trump added “Our relationship with Iran is becoming a much more professional and productive one.”
We are sticking to our view the dollar index (DXY) risk overshooting the upper end of its nearly one year 96.00-100.00 range in the near term. Resilient US economic activity in both absolute and relative terms outweigh the drag to USD from improving sentiment tied to the Iran war. The Atlanta Fed GDPNow model estimates annualized US real GDP growth of 4.3% in Q2 vs. 2.0% in Q1 while the May PMI data points to a widening US growth edge over peers.
Kevin Warsh has been sworn in as Fed chair on Friday, becoming its 17th chair since 1913, and its 11th since the modern FOMC structure was established in 1936. Check out our note Once Upon a Time at the Fed to see what a Warsh-led Fed means for markets. We think he’ll disappoint markets expecting a more dovish Fed tilt.
PCE on Deck
US April PCE (Thursday) is this week’s data highlight. Headline PCE is seen rising 0.5% m/m or 3.8% y/y vs. 0.7% m/m or 3.5% y/y in March. Core PCE is expected at 0.3% m/m or 3.3% y/y vs. 0.3% m/m or 3.3% y/y in March. Both headline and core PCE inflation are overshooting the FOMC’s 2026 projection of 2.7%, underscoring pricing for a more restrictive Fed stance.
Fed Chair Kevin Warsh said during his Senate confirmation hearing he preferred to follow “trimmed averages” inflation as opposed to core PCE price index. The Dallas Fed trimmed mean PCE and the Cleveland Fed 16% trimmed mean CPI are currently below core PCE, implying room for the Fed to loosen policy.
Regardless, the center of gravity on the FOMC has shifted from an easing to a more neutral bias raising the risk that Warsh becomes the first modern Fed chair to be outvoted on policy.
Even dovish-leaning Fed Governor Chirstopher Waller pumped the brakes on cuts last week highlighting “my current policy position is to hold rates steady for the near term…But I can no longer rule out rate hikes further down the road if inflation does not abate soon...” Waller added “I would support removing the "easing bias" language in our policy statement to make it clear that a rate cut is no more likely in the future than a rate increase.”
ECB Account: Hawkish Undertone
The ECB’s Account of the April 30 rate decision (Thursday) will provide more insights into policymakers’ tightening bias. At that meeting, the ECB kept interest rates on hold at 2.00% for an 8th consecutive meeting. The decision was unanimous, but ECB President Christine Lagarde flagged members debated “at length and in depth, a decision to possibly hike.”
Markets continue to imply 86% odds of a 25bps ECB rate hike to 2.25% at the next June 11 meeting. Rate hikes in a low growth, high inflation environment, is not bullish for EUR but should help cushion the downside. We see room for EUR/USD to stabilize lower at 1.1400, reflecting a stronger US growth outlook relative to the Eurozone.
Central Bank Watch
Bank of Israel (BOI) policy decision is Monday. BOI is expected to cut rates 25bps to 3.75% after pausing easing at the last March meeting. Isarel headline CPI inflation has been running just below the midpoint of the bank’s 1-3% target range since January and the economy contracted more than expected in Q1 due to war-related business shutdowns.
Bank researchers estimate the policy rate to average 3.50/3.75% in Q1 2027. The swaps market is more aggressive and implies nearly 125bps of cuts in the next twelve months that would see the policy rate bottom closer to 2.75%.
ILS outperformed all major currencies since the start of the Iran war on February 28, with USD/ILS trading at its lowest level since November 1993 around 2.8900. ILS strength reflects the AI/data-center spending boom supporting inflows into Israel’s large tech sector (roughly 20% of the GDP) and expectations for a rapid post-war economic recovery. However, ILS upside is increasingly looking overstretched, with the shekel 15% overvalued relative to its real effective exchange rate trend.
National Bank of Hungary (MNB) policy rate decision is Tuesday. MNB is widely expected to keep rates steady at 6.25% for a third consecutive meeting. The euro-convergence trade will continue to be an important structural tailwind for HUF. Hungary’s new government plans to meet euro adoption conditions by 2030.
The RBNZ policy decision and Monetary Policy Statement are due on Wednesday. The RBNZ is widely expected to leave the Official Cash Rate (OCR) unchanged at 2.25% for a third straight meeting. The swaps market implies a 25bps RBNZ rate hike at the July 8 meeting, and a total of 125bps of tightening over the next twelve months to 3.50%.
The RBNZ updated OCR path will likely remain consistent with a more muted tightening cycle, totaling 75bps of hikes by 2029. The RBNZ sectoral factor inflation model and 2-year inflation expectations are within the bank’s 1-3% target range while New Zealand’s economy continues to operate below capacity.
Bottom line: scope for a downward adjustment to NZ rate expectations is a headwind for NZD. NZD/USD should continue to trade within a narrow 0.5800-0.6000 range in the near term.
South African Reserve Bank (SARB) policy decision is Thursday. SARB is expected to raise the policy rate 25bps to 7.00% after keeping rates on hold the last two meetings, effectively ending an easing cycle that began in September 2024. Headline CPI inflation in April was right on the bank’s Q2 forecast of 4% y/y. But core CPI inflation of 3.6% y/y in April is overshooting the bank’s Q2 forecast of 3.3% and argues for a hike. The swaps curve price in 100bps of hikes in the next twelve months.
Bank of Korea (BOK) policy decision is Thursday. BOK is expected to keep the policy rate unchanged at 2.50% for an 8th consecutive meeting. The risk is a hawkish surprise to curtail KRW weakness. KRW is the fourth worst performing currency since the start of the Iran war on February 28, largely because of South Korea’s negative net energy balance.
Last week, South Korean FX authorities warned that the currency’s drop is “excessive relative to economic fundamentals, and will take decisive action if necessary.” The swaps curve price in nearly 125bps of hikes in the next twelve months.
